Commentary: Subprime Thinking

FOMC Statement, December 14, and the Recent Increases in Bond Yields – Since "proponents" argue that QE2 will work through reductions in long bond yields, clearly they would like to see those reductions in the data. But, as is evident to everyone, including the NYT, bond yields have gone up, not down. The top line in the chart (sorry for the crappy chart, by the way) is the nominal yield on 10-year Treasuries. Encouragingly for the Fed, this rate fell in the period when it was becoming clear that the Fed would embark on some kind of quantitative easing program, leading up to the November 3 QE2 announcement. Better still, the 10-year TIPS yield, the bottom line in the figure, fell during this period, and by more than the nominal yield. We can take the 10-year TIPS yield as a measure of the real rate of interest over a 10-year period, which is what the FOMC proponents of QE2 would think of as the real rate of interest relevant for influencing economic activity. Note as well that the break-even inflation rate (the inflation rate required to equate realized rates of return on nominal bonds and TIPS – the difference beween the nominal bond yield and the TIPS yield) rose over the period leading up to November 3. This is even better for the Fed, as it reflects an increase in inflationary expectations.
 
Commentary: Subprime Thinking – When I started this blog in January 2005, one of my goals was to alert people to the housing bubble, and to discuss the possible consequences of the then approaching housing bust. Residential investment has historical been one of the best leading indicators for the economy, and I was deeply concerned a major housing bust – both in terms of activity and house prices – would take the economy into recession.When the Financial Crisis Inquiry Commission was announced, I was skeptical if they’d be willing to address the willful lack of regulatory supervision, and the role of Wall Street in the crisis. This morning, Shahien Nasiripour at the HuffPo wrote: Financial Crisis Panel In Turmoil As Republicans Defect; Plan To Blame Government For Crisis.   Republicans voted in favor of banning the phrases "Wall Street" and "shadow banking" and the words "interconnection" and "deregulation" from the panel’s final report, How depressing.Lets name names: Bill Thomas, Peter Wallison, Keith Hennessey and Douglas Holtz-Eakin. These are all subprime thinkers.

 
Finally, everything is good again – THE news out of the American economy keeps getting better and better. The country’s trade deficit has fallen thanks to improved exports. Retail sales are beating expectations. Industrial production has been growing steadily, and service sector activity is growing at an increasing rate. Consumer confidence is up. And the Dow Jones Industrial Index has finally regained all the ground lost after August of 2008. The deal on extension of the Bush tax cuts led some major macroeconomic forecasters to revise 2011 growth expectations up to around 4%. The retail sales surprise this week led to similar upward revisions for fourth quarter output. It seems, at last, that good times are here again. Except. Unemployment is at 9.8%. Over 6m Americans have been out of work for more than 6 months. Some 2m jobless workers will exhaust unemployment benefits by the end of 2010. Housing prices, nationally, are falling once again. Nearly 11m households have mortgages larger than the value of their homes. Consumers are still heavily indebted, which will constrain further growth in spending. So, should we be optimistic about the American economy or pessimistic?
 
IPhone Adds $1.9 Billion to U.S.-China Trade Deficit – One widely touted solution for current U.S. economic woes is for America to produce more of the high-tech gadgets that the rest of the world craves. Yet two academic researchers have found that Apple Inc.’s iPhone — one of the most iconic U.S. technology products — actually added $1.9 billion to the U.S. trade deficit with China last year. ( Read the research)How is this possible? Though the iPhone is entirely designed and owned by a U.S. company, and is made largely of parts produced by other countries, it is physically assembled in China. Both countries’ trade statistics therefore consider the iPhone a Chinese export to the U.S. So a U.S. consumer who buys what is often considered an American product will add to the U.S. trade deficit with China.
 
 Brown wants to fast-track budget agreement within 60 days.- Gov.-elect Jerry Brown said Tuesday that he wants to complete a budget agreement within two months of unveiling his budget, an accelerated timeline that would allow a late-spring special election for potential tax increases or other revenue generation. "We’ll present a budget on Jan. 10. It will be a very tough budget, but it will be transparent," he said. "We’ll lay it out as best I can. We’ve been living in fantasy land. It is much worse than I thought. I’m shocked." A spokesman later sought to play down the timeline, calling it "an ambitious goal." Brown has refused to publicly discuss his budget plans, but he has met privately with lawmakers and interest groups. People involved in the meetings expect him to enact an austerity budget in the spring, then hold a special election in which voters can decide whether to raise taxes or other revenues in order to restore services. He pledged during the campaign not to increase taxes without voter approval.

Inflation: Core CPI, Median CPI, 16% trimmed-mean CPI remain below 1% YoY – In addition to the CPI release this morning from the BLS, the Cleveland Fed released the median CPI and the trimmed-mean CPI:  According to the Federal Reserve Bank of Cleveland, the median Consumer Price Index rose 0.1% (1.0% annualized rate) in November. The 16% trimmed-mean Consumer Price Index increased 0.1% (1.1% annualized rate) during the month. … Earlier today, the BLS reported that the seasonally adjusted CPI for all urban consumers rose 0.1% (1.5% annualized rate) in November. The CPI less food and energy increased 0.1% (1.2% annualized rate) on a seasonally adjusted basis. Over the last 12 months, the median CPI rose 0.5%, the trimmed-mean CPI rose 0.8%, the CPI rose 1.1%, and the CPI less food and energy rose 0.8% So these three measures: core CPI, median CPI and trimmed-mean CPI, all increased less than 1% over the last 12 months. This graph shows these three measure of inflation on a year-over-year basis. They all show that inflation has been falling, and that measured inflation is up less than 1% year-over-year.

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The Climax is Coming – So if everything goes as Bernanke expects (or hopes), inflation, i.e. the general price level, will rise a bit, to around two percent. The banks will remain solvent in spite of the fact that they are still carrying billions of bad loans and that real estate will continue to fall in value. Freddie and Fannie will survive. The unemployed will begin to find jobs. U.S. Bonds will continue to sell at low interest rates and the Treasury will be able to finance the biggest budget in history. The U.S. dollar will retain its reserve status because the Chinese and other U.S. financiers will continue to play the game, in spite of the fact that the dollar will continue to lose purchasing power relative to other store-of-value items (e.g., gold and perhaps other currencies). . On the other hand, if things don’t go as he expects, commodities will blow off the charts. Retailers will find themselves forced to pass along costs, and general prices will start to rise even though real estate will continue to tank. U.S. bonds will take a big hit and reveal themselves to have been in bubble territory up until two months ago. Banks will find themselves in the interest-rate squeeze. Foreign trading partners will continue the currency race to the bottom and impose more restrictions. The American workforce will profit from the additional year of benefits the government might hand out, and the unemployment figures will not budge or may get worse. General unrest will rise in parts of the world that depend upon commodity prices remaining stable.
 
Orwell and the Financial Crisis – Krugman – Barry Ritholtz catches AEI purging mention of deregulation from Peter Wallison’s bio. Wallison is co-director of AEI’s financial deregulation project; but he’s also one of the Gang of Four demanding that the Financial Crisis Inquiry Commission not so much as mention deregulation in its report. So Wallison’s history as an advocate of the policy that shall not be named must be expunged, I guess. If this sounds familiar, it should. The same thing happened with Social Security privatization. There was a long effort by conservative groups to promote privatization, a term they themselves devised. Cato had a Project on Social Security Privatization. But then, when it turned out that the term polled badly, they began rewriting old records in an attempt to cover up the fact that they had ever talked about it.

Tax Deal Could Be Fed’s Savior – It’s looking increasingly likely a new round of government stimulus spending will determine the future of the Federal Reserve’s controversial Treasury bond buying program. On Tuesday, the Fed left in place its agenda of 0% interest rates and again committed itself to buying $600 billion in longer-dated Treasurys as it tries to engineer a better level of growth that will bring inflation up and away from its current flirtation with deflation, while at the same time lowering the unemployment rate. Thus far, it is hard to say what effect the bond buying effort has had. While bond yields fell as the Fed moved toward announcing the program’s launch, they have risen since the early November Federal Open Market Committee meeting launching the effort. While it’s possible to have a positive read on that development, interpreting higher yields as a vote in favor of rising price pressures and better growth, it could also signal the Fed has chosen an ineffective path to providing fresh stimulus.
 
State of Working America preview: A staggering rise in health insurance costs – Family health insurance premiums more than doubled between 1999 and 2009, far outpacing the growth in workers’ earnings and overall inflation. The Figure, from EPI’s forthcoming State of Working America Web site, plots the rise in health insurance premiums against both inflation and hourly earnings for nonsupervisory and production workers, who comprise 80% of the private-sector workforce. While family health insurance premium costs grew 131% over the past 10 years, inflation over that same period rose just 28.8% and hourly earnings rose by 38.1%. Since health insurance premiums are often shared between workers and their employers, this disproportionate rise in the cost of health insurance helps illustrate why it is increasingly difficult for both employers and their workers to afford.
 
3% of the Tax Cut Deal – The Senate is about to pass the full tax cut “compromise,” but House Democrats are trying to hold out for a more fiscally responsible option.  From the Washington Post:   After meeting for two hours with rank-and-file lawmakers late Tuesday, senior Democrats said the House is likely to stage votes to change the terms of a revived estate tax that many Democrats view as overly generous to the wealthy. Outraged by the agreement to exempt individual estates worth as much as $5 million from taxation, senior Democrats said they would press to lower the threshold to $3.5 million.  House Democrats said their alternative would hit only about 6,600 of the nation’s wealthiest households while raising an additional $26 billion over the next two years compared with the Obama-GOP compromise – money that could be used to reduce the soaring national debt.  I agree that we shouldn’t need to deficit spend that additional $26 billion, which would benefit such a tiny fraction of the richest Americans who don’t exactly need any help–to spend or to save or to do whatever.  But this is an even more perverse version of President Obama’s wish to “save” the $700 billion 10-year cost of extending the high-end Bush tax cuts while urging the deficit spending of the $2.2 trillion 10-year cost of extending all the rest of the Bush tax cuts.  Note that the $26 billion House Democrats wish to shave from the estate tax cut, for fiscal responsibility’s sake, is just 3 percent of the cost of the ($858 billion) tax cut deal. 
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